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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Lok’nStore Group Plc’s (LON:LOK) P/E ratio to inform your assessment of the investment opportunity. Lok’nStore Group has a P/E ratio of 32.19, based on the last twelve months. That corresponds to an earnings yield of approximately 3.1%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Lok’nStore Group:
P/E of 32.19 = £4.2 ÷ £0.13 (Based on the year to July 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Lok’nStore Group increased earnings per share by an impressive 18% over the last twelve months. And it has bolstered its earnings per share by 23% per year over the last five years. So one might expect an above average P/E ratio. Unfortunately, earnings per share are down 2.0% a year, over 3 years.
How Does Lok’nStore Group’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Lok’nStore Group has a much higher P/E than the average company (9.1) in the real estate industry.
Its relatively high P/E ratio indicates that Lok’nStore Group shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Lok’nStore Group’s Debt Impact Its P/E Ratio?
Lok’nStore Group’s net debt is 26% of its market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On Lok’nStore Group’s P/E Ratio
Lok’nStore Group has a P/E of 32.2. That’s higher than the average in the GB market, which is 15.6. While the company does use modest debt, its recent earnings growth is impressive. So it does not seem strange that the P/E is above average.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.